20VC Are LPs Open For Business What Does it Take to Raise a Fund Today How Has What LPs Want to See in Fund Investments Changed Why Do LP Incentive Mechanisms Need to Change Which Funds Will be Hit Hardest with Beezer Clarkson @ Sapphire Partners

In a comprehensive discussion on the venture capital ecosystem, Harry Stebbings of "20VC: The Memo" delves into the current state and future of Limited Partners (LPs) with Beezer Clarkson of Sapphire Ventures. They explore the challenges facing LPs, such as liquidity strains and the changing dynamics of fund-raising cycles, emphasizing the critical role of power law in portfolio performance and the necessity for venture funds to secure significant, fund-returning companies. Clarkson advises new LPs to grasp the power law's impact and discusses the complexities of LPs' diverse strategies, including their approaches to diversification and investment buckets. They also touch on the evolving landscape of fund sizes, the debate over management fees and GP commitments, and the potential long-term effects on the relationship between TVPI and DPI due to recent market conditions. Clarkson highlights the importance of consistency in venture investing and the rigorous journey from emerging manager to established fund, reflecting on the industry's shifting preferences and the resilience required for long-term success.

• Limited Partners (LPs) may be compensated based on DPI (Distributions to Paid-In) or TVPI (Total Value to Paid-In).
• The way LPs hold their portfolio affects their compensation and external assessments.
• LPs sometimes pre-spend future budgets, which can lead to liquidity strains in market downturns.

"Lps, some get paid on DPI, some get paid on TVPI, meaning that how they're holding their portfolio is relevant to how they are viewed, not just for their personal paycheck, but how they might be measured by an external us news and world report."

This quote explains the different compensation structures for LPs and how portfolio management can affect their personal income and professional evaluation.

• The focus of the podcast is the current state of LP markets, including whether LPs are "closed for business," the changes in what they seek from managers, and the anticipated changes over the next twelve months.
• Beezer Clarkson from Sapphire Ventures is the guest, known for her expertise in LP investment.

"Today we go deep on the core topic of are lps closed for business? What has changed and what they want to see from managers that they look to invest in? And how do lp markets change over the next twelve months?"

Harry Stebbings introduces the core topic of the podcast, highlighting the focus on LP activity in the current market environment.

• Cooley is a global law firm specializing in startups and venture capital.
• Harvard Management Company (HMC) seeks out great investors and entrepreneurs, managing Harvard University's endowment and partnering with fund managers.

"Cooley is one of the most active firms in advising in both early and late stage financings... HMC has managed Harvard University's endowment for nearly 50 years and was one of the first institutional investors in venture capital."

Harry Stebbings provides information on Cooley and HMC, emphasizing their roles and expertise in supporting the venture capital ecosystem.

• Beezer Clarkson manages Sapphire Partners, focusing on early-stage venture funds in the US, Europe, and Israel.
• She discusses the importance of understanding the power law in venture capital and its impact on fund performance.

"Well, I'm Beezer, so I manage Sapphire partners, which is the LP strategy of Sapphire, and we invest in early stage venture funds, US, Europe and Israel, and that's what I do."

Beezer Clarkson introduces herself and explains her role at Sapphire Partners, emphasizing their investment focus.

• Understanding the power law is crucial for LPs to comprehend venture dynamics.
• A portfolio needs high-return companies to achieve outperformance; small, consistent returns are not enough.

"I would say really understand the importance of the power law, which I know sounds like a bit of a nitty gritty... It's hard to walk that until you really feel it."

Beezer Clarkson emphasizes the importance of the power law in venture capital, indicating that it is a fundamental concept that LPs must grasp to understand venture dynamics and performance.

• LPs differ in their approach to diversification; some focus on avoiding overlaps, while others may invest in overlapping areas.
• LPs must consider the potential returns on their investments relative to the amount they put into funds.

"Lps are like snowflakes, no two are the same. So some people do like diversification... And it really comes down to how the LP wants to build their portfolio."

Beezer Clarkson describes the diversity of LP strategies regarding portfolio diversification, suggesting that there is no one-size-fits-all approach.

• Sapphire Partners focuses on early-stage investments, including seed and pre-seed.
• Consumer exits can be larger but are less frequent than enterprise exits, which tend to be more consistent but smaller.

"We are proud venture geeks and we do publish some of our findings... enterprise does tend to have more consistency of exits, but you get the big spikes in the consumer ones."

Beezer Clarkson shares insights into sector-specific exit dynamics, highlighting the differences between consumer and enterprise exits.

• The pace of fundraising affects LPs' budget management and investment decisions.
• Current market conditions are causing LPs to face liquidity strains and budget constraints.

"Right now, given what's going on in the markets, a lot of lps are feeling liquidity strains. I wouldn't say a crunch, but there's different demands on those dollars."

Beezer Clarkson discusses the impact of market conditions on LPs, indicating that many are experiencing liquidity strains due to the demands on their capital.

• LPs are being selective but are still making new investments.
• The volume of dollars invested in funds may decrease, and the frequency of fund-raising may extend back to traditional timelines.

"That's not true. I think lps are being more selective and making new investments, but they're absolutely making new investments."

Beezer Clarkson refutes the notion that LPs have stopped making new commitments, asserting that they are still investing but with greater selectivity.

• LPs face difficult decisions regarding investment commitments, especially if they have pre-spent future budgets.
• Some LPs may pause investments to rebalance, despite the risk of missing out on market opportunities.

"Some lps will say we believe we can get back in later. Some lps have to exit."

Beezer Clarkson acknowledges the challenges LPs face in managing their investment commitments during market fluctuations and the different strategies they may employ.

• There is uncertainty about when IPO markets will reopen, affecting liquidity for venture investments.
• LPs may need to adjust their strategies and expectations for liquidity events.

"It's going to be tough... But if you have a bunch of existing managers who are still putting money in the ground, you could probably skip a year and still have money going in, just not be re upping or making new investments."

Beezer Clarkson discusses the potential for prolonged illiquidity in venture capital and how LPs might navigate this environment by adjusting the timing of their investments.

• The market is experiencing a disconnect, where sellers are hesitant to agree to the steep discounts buyers want.
• There is a visible trend, but the full extent of market adjustments has yet to be realized.
• If the market does not recover, endowments, foundations, and other limited partners (LPs) will face difficult decisions regarding portfolio management.

"Somebody wants an 80% discount and the person selling might not want to sell at an 80% discount." This quote highlights the current gap between buyer and seller expectations in the market, indicating a struggle to reach agreement on valuations.

• Emerging managers face a dilemma: sell promising early positions at a discount for immediate returns (DPI) or hold for long-term gains (TVPI).
• The decision impacts their ability to raise subsequent funds and balance short-term liquidity with long-term strategy.

"Think emerging managers who have maybe some really promising, exciting early positions that they could sell, but at a steep discount, should they sell them to get the DPI to raise the next funds, or should they stay true, hold them because they are long term winners, but then have TVPI, not DPI?" This quote presents the strategic conundrum for emerging managers on whether to focus on immediate distributable returns to attract new LPs or to prioritize long-term value creation.

• The criteria for LPs selecting fund managers have evolved, with a focus on getting into great companies, being good fiduciaries, and managing teams effectively.
• During bull markets, LPs, like GPs, were susceptible to FOMO, but in bear markets, they are reassessing their strategies with more scrutiny.

"I think today you want to see what you've always wanted to see in the past, but people have released a bit on the aperture around it, which is you want to see people that are going to be getting into great companies, good fiduciaries, and managing their team." This quote explains that while the fundamental criteria for LP investment decisions remain the same, the approach to evaluating these criteria has become more nuanced and cautious in recent times.

• Institutional LPs that invest in first-time funds tend to support spinouts and are more likely to continue with a Fund II, assuming no major negative changes.
• The traditional three-year deployment cycle for funds is changing, with faster deployment potentially affecting the evaluation of a Fund III's success.

"If you're an institutional lp coming into a fund one...they will do fund two, because you just will not have enough data to know till fund three." This quote addresses the commitment of institutional LPs to continue investing in a Fund II due to the lack of sufficient performance data within the first few years of a fund's operation.

• Fund sizes are being adjusted, with early-stage funds decreasing in size to adapt to market conditions.
• The adjustments reflect changes in round sizes and investment strategies.

"We already are. I'm just looking at the early stage, but the growth has been very." This quote confirms that fund size adjustments are already happening, particularly in the early-stage investment space.

• LPs are showing a preference for mid-sized funds that offer the potential for good returns with reasonable risk.
• There is a realization that very large or very small funds may not be optimal for most LPs' risk profiles and investment strategies.

"I hear a lot from LPS. I would like to be able to write a 2020 $5 million check. I want to be able to grow it over time." This quote suggests that LPs are looking for investment opportunities that allow for scalable commitments and growth potential within a certain fund size range.

• There is debate over whether success in venture capital persists over time, with some LPs believing in a persistency bias where successful fund managers continue to perform well.
• This belief influences LPs' decisions to invest with certain managers based on their track record and deal flow.

"So there is the whole myth or not myth of the persistency bias and venture, right?" This quote introduces the concept of persistency bias, where past success in venture capital is believed to be indicative of future success, affecting the flow of capital and investment decisions.

• The proliferation of micro funds has been supported by other VCs and individuals in the industry.
• There is uncertainty about the future of micro funds, but there is a belief in their potential power and utility in the venture ecosystem.

"We haven't seen it yet. And I really don't wish the death of the microfunds." This quote expresses a hope for the continued existence and relevance of micro funds in the venture capital landscape.

• The signal strength of certain investors, such as endowments and foundations, can influence others' investment decisions.
• It is important to understand the role an investment plays in one's portfolio and the reasons behind others' investment choices.

"You have to dig a little deeper and say, well, who are they and why are they doing this?" This quote emphasizes the need for investors to look beyond the surface-level signal of an investment and consider the underlying motivations and portfolio fit.

• Attitudes towards risk and the focus on maximizing upside differ among investors, with some being more concerned about preserving capital and others about achieving exceptional growth.
• Success in venture capital requires a balance between fear of loss and the pursuit of high returns.

"When you're swinging for the fences, going back to what I said before, it is incredibly hard to be an early stage fund that has outperformance without a couple fund returners." This quote underlines the venture capital philosophy that significant outperformance often necessitates taking risks for potentially high-return investments.

• Smaller funds require a higher hit rate or larger exits relative to fund size.
• Trade-offs between ownership and assets under management (AUM) become apparent in funds over $50 million.
• Exceptional cases like Coinbase can significantly impact fund performance regardless of size.
• A $50 billion exit is transformative, but a $10 billion exit may not be as impactful for larger funds.

"We've yet to run the math and see a fund that's gone over 50 million, that doesn't have to start having some trade off between ownership and aum." The quote indicates that beyond a certain fund size, typically $50 million, there is a necessary balance to be struck between the percentage of ownership in portfolio companies and the total assets under management.

• Investing in funds involves both quantitative analysis and qualitative judgment.
• Funds typically underwrite to different multiples depending on the stage, with Series A targeting a 3x return and Series C targeting a 5x return.
• The probability of achieving multiple $2 billion exits within a fund is a critical consideration.
• Historical performance can inform expectations but isn't a guarantee of future results.

"Investing in a fund is art and science, and the science part cleans the deck very. But the art is very hard on the people, right?" This quote emphasizes that while there is a scientific, mathematical aspect to fund investment, the qualitative, human element is challenging and critical to success.

• There is a need for more candid discussions with limited partners (LPs) about portfolio performance.
• Venture capital is inherently risky, and not all investments will succeed.
• The recent market has seen lower loss ratios, which may not be indicative of typical venture capital performance.

"Venture is a risk business. You don't go into early stage and expect every company to work." The quote reinforces the inherent risks involved in early-stage investing and the reality that not all investments will yield positive outcomes.

• Discrepancies exist in how different managers value their portfolio companies.
• LPs often discount the valuations provided by general partners (GPs) due to uncertainties.
• The impact of AI and market changes can rapidly alter company valuations and competitiveness.

"Well, I know a lot of lps that will ask their managers and then go back home and take another 20% to 25% off the top, because there's things that nobody knows." This quote highlights the skepticism LPs may have towards the valuations reported by their fund managers, leading them to apply their own discounts to account for unknowns.

• The valuation process can be inconsistent across different funds.
• GPs may not always have the same information, particularly if they are not on the board.
• Auditors may enforce valuation based on recent funding rounds, which can be problematic if market conditions have changed significantly.

"But that last year, the end of 2022, when the auditors were getting involved, they were telling gps to talk to each other, to try to figure out how to value things, because if you weren't close enough to a public comp, you had to value it off of the last raise." This quote discusses the challenges and methods used in valuing companies, especially when there are no recent public comparables and auditors are involved.

• The size of a fund can create misalignments between the interests of GPs and LPs.
• Management fees and personal compensation can diverge from the financial objectives of LPs.
• Discussions around fees and GP commitments should consider the specific circumstances of the fund and its management.

"I think depending on who you are as an LP, the fund size can drive some misalignment." This quote suggests that the size of a fund can lead to differing priorities and potentially conflicting interests between fund managers and their investors.

• LPs may advise GPs to slow down their investment pace.
• Some funds have established expectations for annual fundraising, while others are encouraged to extend timelines.

"I think there's been many conversations with lps suggesting gps slow their role." The quote indicates that LPs are engaging in discussions with GPs about the pace of investment and the timing of fundraising efforts.

• LPs may express concerns about missed opportunities for taking profits during favorable market conditions.
• Managers are increasingly seeking soft landings for companies that aren't performing well.
• The decision to sell or hold positions can be influenced by various factors, including market conditions and fiduciary responsibilities.

"You hear a lot of people having concerns that they're now going to ride the TVPI all the way back down to your point, you can manufacture some distributions, right?" The quote reflects the worries of LPs regarding the potential decline in the total value to paid-in (TVPI) ratio and the need for strategic distributions to manage fund performance.

• Pitchbook released a new ranking of venture capital firms.
• Union Square Ventures secured the first and third spots in this ranking.
• Metrics used for ranking may include capital calls versus distributions.

"Pitchbook just did a new ranking based on I'm not sure what metrics they pulled. It was like capital calls versus distributions. And I don't know how they knew this, but Union Square had the first and the third spot, so shout out to them."

The quote indicates that Union Square Ventures achieved notable positions in Pitchbook's new venture capital firm ranking, though the exact metrics used are unclear to the speaker.

• Founders Fund is experiencing a notable period of success.
• Index Ventures is recognized for the consistency of their DPI (Distributions to Paid-In capital).

"I think founders fund having a moment in the sun and then just index consistency of DPI."

This quote highlights the current success of Founders Fund and the consistent performance of Index Ventures in terms of DPI.

• Speaker A dislikes being told that something is impossible.
• Believes that just because something hasn't been done before, it doesn't mean it can't be done.
• Hard work is essential to achieve what has not yet been achieved.

"I hate being told something's not possible and that you can't do it. Just because someone hasn't done it before doesn't mean you can't do it. It just means it's harder."

Speaker A expresses a dislike for negativity regarding the possibility of innovation, emphasizing that unachieved tasks are not impossible but rather require more effort.

• Speaker A wishes LPAs were better, finding them hard to read, complicated, and not particularly useful.
• LPAs should be tools to understand the relationship between parties but often become legal complexities.

"I wish the LPA was better. It's so hard to read. It's so complicated. It's so not useful."

This quote conveys the speaker's frustration with the current state of LPAs, suggesting they are overly complex and not user-friendly.

• Great venture firms understand the unique interplay between the investor's identity and the firm's structure.
• Building a long-enduring firm requires recognition of this unique interplay.
• Many people underestimate the difficulty of creating a successful venture business.

"Most the great managers understand this. Who they are as an investor and how they build their firm is so specific to them."

The quote emphasizes that successful venture managers and firms have a strong sense of identity and tailor their approach accordingly.

• Venture firms often take much longer than the commonly cited ten years to establish.
• Each fund cycle can be a long-term endeavor, with significant time and financial commitments.

"Everyone says ten years. It's not ten years, it's like 1520. And that's just one fund."

Speaker A corrects a common misconception about the time it takes to establish a venture firm, indicating that it often takes much longer than a decade.

• Speaker A regrets passing on the Initialized Fund One due to its size and stage being outside of their investment scope.
• Emphasizes the importance of making exceptions for exceptional people.

"I passed on the initialized fund one, because we had just launched. Yes, I know it was bad, but the reason 300. I know. No, trust me, I know."

This quote reveals Speaker A's missed opportunity to invest in Initialized Fund One and acknowledges the hindsight regret of not making an exception.

• Speaker A discusses the importance of taking significant risks in early-stage investments.
• Suggests that a growth equity mindset may not yield long-term performance in smaller, earlier funds.

"It's so clear in early stage, if you're not taking a big swing for the fence, which doesn't mean saying taking like ridiculous, I haven't thought about it risks, right? But you just have a lot of people that think that they can do sort of smaller investments."

Speaker A stresses the need for substantial risk-taking in early-stage investing to achieve high returns, as opposed to a more conservative growth equity approach.

• Discusses realistic performance expectations for sub $50 million seed funds.
• Aiming for a five times return is challenging, and a ten times return is even more difficult to achieve.

"You often hear that, I'm going to definitely be a ten x. You know how freaking hard it is to a ten x?"

Speaker A questions the common but overly optimistic expectation of achieving tenfold returns in seed-stage investing.

• Achieving strong DPI across multiple funds is indicative of world-class performance.
• It's common for funds to experience challenging vintages, such as in 2021.

"If you can get three or four funds in a row with strong DPi, that is world class."

This quote highlights the rarity and significance of maintaining high DPI returns across several consecutive funds.

• Institutional LPs seek managers they can partner with over multiple fund cycles.
• There is a significant drop-off rate from fund one to fund two and from fund one to fund four.

"The breakage between fund one and fund two is not every year, but averages out to be about 50%."

Speaker A provides data on the high attrition rate between the first and second funds, indicating the challenges in sustaining venture funds over time.

• The main reasons for funds not progressing include performance visibility, strategy, and team dynamics.
• Partnership breakdowns and the inability to raise subsequent funds are also contributing factors.

"Maybe you did so well you didn't want to keep going. There's a positive side of that, which is it's good."

Speaker A suggests that there can be positive reasons behind a fund's discontinuation, such as achieving sufficient success.

• LPs have varying opinions on opportunity funds.
• Some LPs participate in opportunity funds as a strategy to gain access to core funds.

"I'm always surprised at the different viewpoints around the room on any given opportunity fund."

Speaker A remarks on the diverse perspectives among LPs when it comes to opportunity funds and their strategic use.

• Unstapling of funds and alignment with LP interests are expected to continue.
• The venture industry is returning to more traditional practices after a period of rapid growth and change.

"I would suspect for at least the next twelve months. To the extent that people feel pressure to raise, they're going to try to be more lp aligned."

Speaker A predicts a trend towards greater LP alignment in venture capital fundraising strategies in response to market pressures.

• Sapphire Ventures has taken over the early-stage venture fund mandate for CalSTRS.
• CalSTRS is the world's largest educator pension fund and has a long-standing emerging manager program.

"We were very excited. We announced this about two weeks ago that we've taken over the early stage venture fund mandate for calsters."

This quote announces Sapphire Ventures' new role in managing early-stage venture funds for CalSTRS, reflecting a significant partnership.

• Speaker A is committed to working with early-stage managers and enjoys being an LP.
• Reflections on past career aspirations and the satisfaction with the current career path.

"No, this is like my life's work. If you said me, what else do you want to do? I used to kind of think I wanted to be secretary of state."

Speaker A shares personal insights about their career journey and the fulfillment found in their current role as an LP working with venture funds.

• Speaker A and Speaker C reflect on their longstanding professional relationship and mutual respect.
• Discuss the importance of relationships and impact in the venture capital industry.

"Oh, thank you for your friendship. And thank you for having me."

The quote expresses gratitude for the professional relationship and the opportunity to have a dialogue about the venture capital industry.

• Cooley is a leading law firm in venture capital and startups.
• Harvard Management Company (HMC) seeks innovative investors and entrepreneurs and has a history of venture capital investment.

"Cooley is one of the most active firms in advising in both early and late stage financings."

This statement highlights Cooley's prominence in the legal aspects of venture capital, while also mentioning HMC's role in supporting the next generation of investors and entrepreneurs.